As a business owner, understanding changes in working capital formula is crucial for sound financial decision-making. In this blog, we’ll dive into changes in working capital formula and explore how it can impact your business.

## Working capital formula: the basics

Before we delve into changes in working capital formula, let’s review the basic formula for calculating it:

Working Capital = Current Assets – Current Liabilities

• Current assets: These are assets that can be converted into cash or used up within one year. They typically include items like cash, accounts receivable, inventory, and short-term investments.
• Current liabilities: These are obligations that need to be settled within one year. Common examples include accounts payable, short-term loans, and accrued expenses.

## Impact of changes in current assets:

• Increase in current assets: If your current assets increase, it will lead to an increase in working capital. For example, if you collect outstanding customer invoices or build up inventory, your current assets rise.
• Decrease in current assets: Conversely, a decrease in current assets will result in a decrease in working capital. For instance, if you experience delays in collecting accounts receivable or sell off excess inventory, your current assets will shrink.

## Impact of changes in current liabilities:

• Increase in current liabilities: When your current liabilities increase, it leads to a decrease in working capital. Taking on short-term loans, accumulating more accounts payable, or accruing additional expenses can contribute to this.
• Decrease in current liabilities: A decrease in current liabilities results in an increase in working capital. For example, if you repay short-term loans or clear outstanding bills, your current liabilities decrease, boosting your working capital.

## Changes in working capital formula

The change in working capital formula is as follows:

 Change in Working Capital = Working Capital (Current Accounting Period) – Working Capital (Previous Accounting Period)

You can also use the following formula to calculate changes in working capital:

 Change in Working Capital = Change in Current Assets – Change in Current Liabilities

## Interpreting changes in working capital formula

Understanding changes in working capital is vital for assessing a business’s financial health. It is closely tracked and analysed by lenders and investors to understand the value and health of a business.

If the change in working capital formula is positive, it indicates that the business has additional resources available, which can be a sign of financial stability. However, a negative value might be a sign of a cash flow problem. A consistent working capital position demonstrates financial stability. It indicates that a business can manage its short-term finances effectively.

Also read: Understanding Changes in Working Capital and Its Impact on Cash Flow

## Key takeaway

To sum up, you need to understand the change in working capital formula to have a clearer understanding of the working capital requirements of a business. By tracking the differences across different accounting periods, SMEs can reduce financial risks and focus on sustainability.

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Ashmita Roy is an Assistant Marketing Manager at Razorpay. When she’s not working, you can find her strumming her guitar or writing poetry. Dislikes writing about herself in third person, but can be convinced to do so via pizza or cheesecakes.

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